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Chapter 22: Securities Law

22.1 Securities Law Generally

Securities law covers the sale of, and other transactions involving, securities. A security (not to be confused with a security interest) is a negotiable instrument that represents some kind of value. Securities can be debt securities (such as banknotes or bonds) or equity securities (such as stocks and ownership interests in other types of business entities). Securities laws are generally enforced by the federal government, most notably by the US Securities and Exchange Commission (SEC) (though other government agencies, such as the federal Commodity Futures Trading Commission, regulate certain types of securities like futures).

22.2 Principal Statutes

Securities Act of 1933 (’33 Act).[1] The ’33 Act was passed in the wake of the 1929 stock market crash. Its primary purpose is to assure the disclosure of all material information in public offerings for the sale of securities, and it sets forth in detail the nature of the disclosures required and the circumstances under which a public offering has occurred.

Securities Exchange Act of 1934 (’34 Act).[2] The ’34 Act regulates the trade in already-issued securities. It sets out a system for registering and reporting the exchange of securities and is designed to mandate honest, equitable and consistent behavior in the market. The ’34 Act prohibits acts that would mislead investors or impair their ability to make a fully-informed assessment about the risks inherent to their investment.

Public Company Accounting Reform and Investor Protection Act of 2002(Sarbanes-Oxley or SOX).[3] Sarbanes-Oxley was enacted as a reaction to several accounting scandals that occurred in the early days of the 21st century. It set new, stringent standards for publicly-traded companies and their boards of directors, managers and accounting firms. Sarbanes-Oxley applies only to publicly-traded companies.

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).[4] Dodd-Frank was enacted as a reaction to the so-called “Great Recession,” the global economic decline from 2007 to 2010. Dodd-Frank brought the most sweeping reforms to financial regulation in the United States since the Great Depression. The changes have affected nearly the entire financial services industry. In implementing Dodd-Frank, the SEC has proposed or adopted various rules regarding asset-backed securities, clearing and settlement, corporate governance and disclosure, credit ratings, derivatives, and oversight of investment advisers and broker-dealers.[5]

Insider trading. One of the more controversial aspects of securities regulation is the concept of insider trading, i.e., buying or selling securities based on knowledge not available to the general public. Among other statutes, the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 set out strict guidelines for what constitutes insider information, what types of transactions are prohibited, and the penalties for engaging in them.

Other relevant federal statutes. Other federal securities laws include the Public Utility Holding Company Act of 1935 (regulating, among other things, a utility company’s ability to engage in non-utility business), the Trust Indenture Act of 1939 (supplementing the ’33 Act with respect to debt securities), the Investment Company Act and the Investment Advisers Act of 1940 (regulating, among other things, the activities of mutual funds and investment advisers), the Securities Investor Protection Act of 1970 (regulating stockbrokers and other dealers in securities), and the National Securities Markets Improvement Act of 1996 (amending securities laws to promote efficiency and provide more effective and less burdensome regulatory regimes between the federal government and the states).

State securities regulation (blue sky laws). In addition to the federal regulations, each state has its own body of laws regulating securities transactions within its borders. These state laws are sometimes called “blue sky laws.” Depending on the circumstance, a transaction may be covered by both federal and state laws.

22.3 Penalties for Securities Law Violations

It is critical for managers of a company to make themselves aware of which federal and state securities laws are applicable, and to secure effective legal counsel in determining how best to comply with the requirements imposed on them. The consequences of a failure to do so can be most dire. Penalties for violations of securities law, particularly willful violations, can be severe. Punishments vary from statute to statute, but can include both enormous fines and prison time. Under Sarbanes-Oxley, for instance, the knowing alteration or destruction of relevant records can be punished by up to 20 years in prison.[6]